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25 August 2020

Transfer Pricing webinar:(L)IBOR Transition and Intra-Group Financing – Transfer Pricing Aspects of an Unprecedented Transformation

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Greetings and introductions

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G E O R G Y G A L U MO V X A V I E R T I N G U E L Y

S A L I M D A M J I

P E T E R N O B S

With you today

Partner, Transfer Pricing and Value Chain Alignment

at Deloitte Switzerland

Deputy Head Group Tax, Julius Bär Group

T H O M A S H U G

Director, Transfer Pricing and Value Chain Alignment

at Deloitte Switzerland

Director, Treasury & Debt Advisory at Deloitte

Switzerland

Manager, Transfer Pricing and Value Chain Alignment

at Deloitte Switzerland

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Agenda

Industry perspective5 22

Focus on key transfer pricing implications4 18

Main aspects of the (L)IBOR transition2 7

Greetings and introductions1 4

Q&A and closing6 23

Overview of treasury and commercial considerations3 15

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Main aspects of the (L)IBOR transition

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What are (L)IBORs?

What are

(L)IBORs

(L)IBORs are benchmarks interest rate at which major global banks lend to one another in the international interbank market for short-term loans

• Published on a daily base for tenors ranging from overnight to 12 months

• Calculated by averaging panel banks submissions

• Include both the expected cost of lending funds and the interbank credit risk (i.e. they are quoted on an “unsecured” base)

Major (L)IBORs

The major (L)IBORs are

• LIBOR – London Interbank Offered Rate – published for USD, EUR, GPB, CHF and JPY / administered by ICE and regulated by the FCA

• Euribor – Euro Interbank Offered Rate – published for EUR / administered by EMMI

• TIBOR – Tokyo Interbank Offered Rate – published for EUR / administered by EMMI

There are (L)IBORs across other currencies, but the bulk of the volume leverages the above reference rates

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Who uses (L)IBORs and what for?

Who uses

(L)IBORs

(L)IBORs are one of the most used benchmark globally, there is an estimated USD 350tn of financial products linked to (L)IBORs

• Main categories of products: Loans, Bonds (FRNs), Derivatives (e.g. IRS), Structured Products

• All industries impacted: Banks, Asset Managers, Corporates, supranational entities

What are

(L)IBORs used for

They are broadly used across institutions

• To price products;

• As discounting factor to value assets (e.g. collateral);

• As benchmark performance; or

• In treasury/risk processes/intercompany agreements (e.g. FTP)

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Why change?

In the aftermath of the 2007-08 financial crisis, it became apparent that these reference rates are inadequate due to their lack of robustness

Decline in liquidity

Reluctance from Panel Banks to submit quotes

Scandals related to alleged manipulations

In 2017, the FCA announced that due to insufficient meaningful data to sustain the LIBOR rate, the benchmark will be discontinued at the end of 2021

By end of 2021, FCA will not compel banks to contribute to LIBOR

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The (L)IBOR transition will not be a simple rate replacement transition

Current state

• Same administrator (ICE) across main currencies (EMMI in case of EURIBOR)

Future state

• Different administrators across the different currencies (e.g. SIX for SARON, The Fed for SOFR)

• Reference rate different across different currencies, with likely different standards, leading to operational challenges

Impact

Decentralised

governance

Structural

changes

Economic

changes

• Term rates published on a daily basis for 7 tenors (from overnight to 12 months)

• IBOR (and EURIBOR) published on an unsecured basis, i.e. inclusion of credit risk in values

• Benchmarks are overnight rates

• Plan for some currencies to publish term rates based on derivatives markets (OIS, futures)

• Secured or unsecured depending on the currency

• Absence of term rate with potentially strong impact on pricing methodology

• Clear communication internally and toward clients to mitigate conduct risk

• Transition with spread adjustment required for CHF and USD

• Transition likely with winners and loser

Three key changes leading to operational, structural and economic challenges that need to be addressed to avoid top- and bottom-line impact

Key changes

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New benchmarks have been determined, but only exist for “overnight”

Replacement rates are currently being defined by the different National Working Groups, decentralised governance leading to operational challenges

LIBOR (today) GBPUSD EUR CHF JPY

Benchmark

(overnight only)LIBOR SONIAESTERSOFR SARON TONAR

National

Working Group

(NWG)

N.a.WG on Sterling Risk-

Free Reference Rates

Alternative

Reference Rates

Committee (ARRC)

WG on Risk-Free

Reference Rates for

the Euro Area

NWG on CHF

Study Group on

Risk-Free Reference

Rates

Term Rate YesPlanned, Q1 2020,

likely based on OIS

Planned, end-2021,

based on OIS

No release date

know, but probably

based on OIS

Not recommendedPlanned, mid-2021,

likely based on OIS

Secured /

UnsecuredUnsecured UnsecuredSecured Unsecured Secured Unsecured

AdministratorIntercontinental

Exchange (ICE)Bank of England

Federal Reserve

Bank of New York

European Central

BankSIX Swiss Exchange Bank of Japan

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New reference rates will be structurally different, in particular SARON

SARON will only be published as an overnight rate, structurally changing the way the market operates today – will price of products only be known at the end of the period?

Impact on

Products

From the market

LIBOR

(Current environment)

SARON

(Future environment)

O/N 1w 1m 2m 3m 6m

Today 3m

LIBOR fixing(Forward-looking)

• LIBOR is published daily for 7 tenors, allowing to know the pricing for a period at the beginning of the period

• Client does not have uncertainty during the period

• SARON only published on an overnight basis

• Period pricing only known at the end of the period by compounding the daily overnights rates

• Client takes on market risk during the period

12m

Key

Considerations

O/N

Toady 3m

Continuously compounded(Backward-looking)

Different options discussed at

the NWG (incl. forward-looking

options) – see next slide

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New reference rates will be economically different, in particular SARON and SOFR

SARON/SOFR are quoted as secured rated (LIBOR is unsecured), there will therefore be a transition spread – depending on the period considered, the spread will be different

• LIBOR is quoted on an unsecure base, while SARON/SOFR are on a secured one

• This implies that there is a credit risk spread between the old and new benchmarks

• The spread between SARON and LIBOR tends to increase during periods of financial turmoil (e.g. 2007-2008), when credit risk is high

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SARON-LIBOR Spread (monthly average)

LIBOR 3M (CHF) LIBOR ON (CHF) SARON

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Overview of treasury and commercial considerations

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Focus on five key topics

What needs to be done before (L)IBOR is terminated by 2021

Fallback Language Identify contracts with duration longer than 2021 Review contracts around trigger event, fallback rate and fallback spread

FX / IR program Identify implications to FX / IR hedging programDefine tactical changes needed now for existing products

Define long-term strategy

AccountingIdentify hedge accounting of interest rate cash flows and instrument valuation techniques based on (L)IBOR

Review possibilities of applying IFRS 9 and IAS 39 relief from the effects of (L)IBOR reform on prospective assessment

TaxesReview impacts from changes in FV as well as transfer pricing agreements incl. LIBOR references

Define measures to avoid changes to financial instruments which could trigger tax events

IT InfrastructureIdentifying systems using (L)IBOR (e.g. yield curves)

Define program architecture and capabilities versus requirements

Impact Analysis Solution Design

• Establishing the scenarios and assumptions• Defining the scope, methodology, tooling and Technology• Gathering and analysing the inputs and data needed to complete the

assessment

• Prepare programme plan including activities, timings, resource, costs and delivery risks

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Define reporting structure to control FX P&L impact of new vs. old IC loan structure

Implement Treasury analytics and reporting

Project successful implemented

Design FX translation hedging structure adapted to your restructured IC loan portfolio

Implement structure (legal, tax and Treasury/FX aspects)

Operate new IC loan FX optimisation structure

Contractual changes according to (L)IBOR transition

Adjust new currency and interest conditions

Impact analysis on changes in FX P&L

Detailed analysis of current IC loan portfolio on FX p&l impact

Analyse local and consolidated impact

Prove IC loan translation impact minimisation

Prepare to group IC loan portfolio to define

Analysis of FX P&L Impact

Redesign IC Loan portfolio

Adapt Hedging Structure

Reporting FX P&L offset

Focus on optimisation of IC loan portfolio and FX translation P&L impact minimisation

What can be done in addition during (L)IBOR transition

• Besides (L)IBOR aspects

focus on FX translation

impacts on local and

group (consolidation)

level

• Use contractual

adaptations to verify a

restructuring of IC loan

portfolio by grouping

loans by few currencies

• Implement FX

translation hedging

structure to offset FX

P&L impact from IC

loans

• Implement reporting to

permanently control

impact

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Focus on key transfer pricing implications

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Main implications from a tax & transfer pricing perspective (I/II)

From a tax & transfer pricing perspective, the IBOR transition and the resulting implications are underpinned by the existing transferpricing rules relating to intra-group dealings:

OECD Guidelines

As per chapter IX of the OECD Transfer Pricing Guidelines for Multinational Enterprises and TaxAdministrations, the termination and/or substantial renegotiation of existing arrangements maybe perceived as business restructuring and may have to be compensated at arm’s length if suchtermination and/or substantial renegotiation would be compensated between independent parties incomparable circumstances.

In addition to this, on 11 February 2020, the OECD issued the final version of the Transfer PricingGuidance on Financial Transactions (the “FT Guidance”). The guidance covers the following:

• Accurate delineation of financial transactions

• Treasury function:

o Treasury centre services

o Intra-group loans

o Passive association

o Cash pooling

o Hedging

• Guarantees

• Captive insurance

• Risk-free and risk-adjusted rates of return

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Main implications from a tax & transfer pricing perspective (II/II)

From a tax & transfer pricing perspective, the IBOR transition and the resulting amendments to existing contracts or valuations mayresult in significant tax & transfer pricing issues:

As a consequence, before amending existing contracts (e.g. loans, derivatives), companies shouldconsider whether this could:

• give rise to a disposal of the existing contract for tax & transfer pricing purposes;

• result in step ups/downs of the principal mounts under consideration;

• require one-off payments in relation to the changes;

• impact the effective margins applied to the arrangements under consideration.

Long-term funding contracts based on IBOR (which extend beyond 2021) should already take thetransition into account.

Where intra-group IBOR funding is being replaced or novated, companies should check that the newmethod of pricing is on arm’s length basis in accordance with transfer pricing rules, so as to ensure thereare no tax return adjustments to deny the deductibility of financing expenses.

Implications

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How to ensure a seamless (L)IBOR transition from a tax & transfer pricing perspective?

Ensuring a seamless (L)IBOR transition requires a holistic approach covering all aspects of the transition:

Evaluation of the tax & transfer pricing risks related to the arrangements impacted by the IBOR transitionand definition of a transition roadmap to mitigate these risks.

Exposure

assessmentIdentification and review of arrangements potentially impacted by the IBOR transition from a tax & transferpricing perspective.

Risk

mitigation

Implementation support to ensure a compliant IBOR transition from a tax & transfer pricing perspectiveincluding transfer pricing documentation and contract remediation.

Operational

readiness

Knowledge sharing

and learning

Development of an understanding for the IBOR transition and its implications, the differences between IBORsand ARRs, and how other companies are organized to handle this transformation from a tax & transferpricing perspective.

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Industry perspective

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Questions?

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Thank you for joining us and see

you next time!

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